Sirius XM Rаdio, Inc., Petitioner, v. Glenn Hegar, Comptroller of Public Accounts and Ken Paxton, Attorney General of the State of Texas, Respondents
No. 20-0462
Supreme Court of Texas
March 25, 2022
On Petition for Review from the Court of Appeals for the Third District of Texas
Argued November 30, 2021
Sirius XM Radio produces radio programming, which it transmits using satellites. Subscribers pay monthly fees to access Sirius‘s programming. To calculate the franchise tax it owes to the State of
Sirius argues that the service it perfоrms for its Texas subscribers is the production of radio shows and the transmission of a radio signal, nearly all of which takes place outside Texas. According to Sirius, a service is “performed in this state” if the people or equipment performing the service are physically located in Texas. The Comptroller disagrees. It argues that the service Sirius performs for its Texas subscribers is the provision of access to its encrypted radio signal, which takes place on each subscriber‘s radio in Texas. The Comptroller reads the Tax Code to allocate services to Texas if the “receipt-producing, end-product act” takes plaсe in this state. Here, the Comptroller contends, the “receipt-producing, end-product act” is the enabling of each subscriber‘s radio to receive Sirius‘s signal.
As explained below, we agree with Sirius. We therefore reverse the judgment of the court of appeals and remand the case to that court for consideration of the parties’ remaining arguments.
I
A
Texas‘s franchise tax is calculated by multiplying the taxable entity‘s “taxable margin” by the tax rate.
Only the second step—apportionment to Texas—is at issue here. Determining the apportioned margin requires calculating what percentage of the entity‘s gross receipts аre “from business done in this state.”
The Tax Code authorizes the Comptroller to adopt lawful rules for “the collection of taxes and other revenues under this title,” which includes Chapter 171.
Sirius broadcasts more than 150 satellite-radio channels, over 70% of which run exclusively original content produced by Sirius. The content is produced in studios mainly located in New York City and Washington, D.C., although Sirius ran a small radio show in Texas for a time. Content is broadcast by transmitting it to satellites from uplink facilities in New Jersey, D.C., and Georgia. The satellites are launched from Kazakhstan. Sirius has tеn satellites orbiting 22,000 miles above the earth. They transmit the signals they receive back down to Earth, where they either reach radio sets or, in densely populated areas, one of Sirius‘s seven hundred terrestrial repeaters (twenty-two of which are in Texas) that supplement its satellite coverage. The satellites are controlled by Sirius‘s facilities in Panama, Ecuador, and Georgia.1 Once the signal reaches a customer‘s radio, a “chip set“—that is, a pair of integrated circuits—decrypts the radio signal, allowing the listener to hear the programming.
Customers can access Sirius‘s content by purchasing one of Sirius‘s radio sets and paying a subscriptiоn fee. Sirius has agreements with auto makers to ensure that new vehicles have Sirius-enabled radios installed. Subscribers typically purchase or lease vehicles with the radios installed rather than purchasing and installing their own. Each subscription is tied to one radio set. When a customer pays a subscription fee, Sirius sends a signal from New York or D.C. that activates the chip set in the satellite radio, which permits the chip set to decrypt radio signals. In many cases, new automobiles come with an active Sirius radio set, so Sirius sends a signal to deactivate and thereby encrypt the radio signal only if the purchaser fails to renew the subscription after his trial periоd ends.
Subscription fees are the primary source of Sirius‘s revenue. The chip set, which is equipped with technology to receive the activation signal and decrypt radio signals, is located in the radio set, but—save for a small number of terrestrial repeaters servicing a limited area—none of the equipment or personnel used to send activation signals to initiate decryption is located in Texas. Sirius creates content in various states, but very little of it is made in Texas.2 It has many subscribers in Texas.
In 2009 and 2010, Sirius paid franchise taxes in Texas. Those tax years are at issue here. In calculating its margin, Sirius was permitted to deduct from its revenue the “cost of goods sold” (COGS).
The Comptroller‘s Office audited Sirius. It determined that Sirius should apportion based on the location of its subscribers, not based on the location where its programs are produced. The Comptroller claimed Sirius underpaid by $878,364.39 for the 2010 tax year and $1,674,907.38 for the 2011 tax year. According to the Comptroller, the “service performed in this state” by Sirius was the service of “unscrambling” the radio signal. The Comptroller reached this conclusion based on its position that services must be apportioned to the state in which the “receipt-producing,
Sirius paid the assessed tax under protest,
The district court found that Sirius performed its services almost exclusively outside Texas. It apportioned to Texas only 0.47% and 0.26% of Sirius‘s total receipts from the two years in question, whereas the Comptroller would have apportioned 8.3% and 8.36%, respectively. The court rendered judgment for Sirius and ordered the Comptroller to refund over $2 million to Sirius. The court affirmed the Comptroller‘s denial of the disputed COGS deduction.
The Comptroller appealed the apportionment issue, and Sirius filed a conditional cross-appeal concerning the COGS deduction. The court of appeals reversed and rendered a take-nothing judgment against Sirius. Agreeing with the Comptroller‘s position that the phrase “service performed in this state” in Section 171.103(a)(2) refers to the “receipt-producing, end-product act,” the court of appeals held that the service performed by Sirius for Texas subscribers was unscrambling the radio signal. 604 S.W.3d 125, 132-33 (Tex. App.—Austin 2020). The court thus agreed with the Comptroller on how to apportion Sirius‘s receipts to Texas. The court then held that the comparative cost of Sirius‘s activities inside and outside of Tеxas was not credible evidence of fair value under its understanding of how to apportion Sirius‘s receipts. Id. at 135. The court of appeals also affirmed the district court‘s judgment regarding Sirius‘s claimed COGS deduction. Id. at 137.
Sirius petitioned for review. It challenges only the court of appeals’ holding that its receipts from Texas subscribers should be apportioned to Texas.
II
A
The parties’ disagreement is largely one of statutory interpretation. The correct interpretation of a statute is a matter of law, which we review de novo. Youngkin v. Hines, 546 S.W.3d 675, 680 (Tex. 2018).3
The primary issue before this Court is whether Sirius‘s receipts from Texas subscribers are receipts from a “service performed in this state.”
Sirius argues that it performs little or no services in Texas. In its view, the phrase “service performed in this state” means that the personnel or equipment performing the service must be physically located in Texas. Sirius contends that the service it performs is not the decryption of radio signals but the production and broadcasting of radio content, which happens outside Texas.
The Comptroller agrees that the proper test is the location where the service is performed, not the location where the service is received. But it contends that Sirius‘s subscribers pay for decryption services in order to access the broadcasted content and that Sirius performs this service where the technology within the radio set is located. Therefore, the Comptroller concludes, the value must be apportioned to Texas, which is the location of the “receipt-producing, end-product act” of unscrambling the radio signal.
Again, the Tax Code requires apportionment based on whether receipts are from a “service performed in this state.”
Generally, all it takes to know where a taxable entity‘s “useful labor” is “done” is to ask where the employees do their work, sinсe businesses act only through their agents. When technology rather than personnel performs the useful act, we look to the location of that equipment, as the Comptroller and courts of appeals have done. Hearing No. 10,028,
We reject the contrary inference that the Legislature, by choosing the passive voice—“performed in this state“—meant for us to ignore the location of the service performer and focus only on the location where the performance is received or its effects felt. The Legislature could have easily designated the place of receipt or the location of the customer as the site of taxation. In fact, the Legislature did so in the immediately preceding provision, which calls for apportionment based on “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state.”
In its original context in an administrative hearing decision, the “receipt-producing, end-product act” test advanced by the Comptroller is not to the contrary.4 It served only to distinguish between the “support services” that enable the entity to do business and thе “receipt-producing” services for which a customer actually pays. As originally employed, the test aimed to tell the Comptroller what qualifies as the “service performed.” It did not tell the Comptroller where a service is performed.
Here, however, the Comptroller would use the “receipt-producing, end-product act” test to determine the location of the service. If pressed into this role, the test is not consistent with the statute. Mechanical application of the test would often require courts to focus on the location where the service is received. But the Legislature chose the word “performed“—not “received“—and any test that blurs this critical distinction parts ways with thе statute.
The focus should be on the statutory words themselves, not on extraneous concepts like “receipt-producing” or “end-product act,” which do not appear in the statute and, when applied, may or may not yield the same result as a straightforward application of the words chosen by the Legislature. That is not to say the statutory text is always easy to apply. It is not. But it should not be replaced by words of limitation or expansion not chosen by the Legislature. Setting aside the atextual and unhelpful “receipt-producing, end-product act” test, the most natural reading of “service performed in this state” supports locating the performance of the service at the place where the taxpayer‘s personnel or equipment is physically doing useful work for the customer.
B
What the text suggests, past precedent confirms. Apportionment goes back to at least 1959, when the predecessor to the present statute was adopted. Act of July 30, 1959, 56th Leg., 3d C.S., ch. 1, § 1, 1959 Tex. Gen. Laws 187. The 1959 statute itself was merely a “codification of long-standing departmental practices.” Humble Oil & Refin. Co., 414 S.W.2d at 180. In general, the taxes many states impose on service businesses can be sorted into “origin-based” and “destination-based” varieties, or those that look to where the service originates versus those that look tо where it is received. See JEROME R. HELLERSTEIN ET AL., STATE TAXATION ¶¶ 9.18[3], 9.18[3][a] (3d ed. 2011).5 The district court here held—and neither party contests—that Texas uses an origin-based system. This means that Texas has long looked to where the service is performed rather than where it is received. Going back to 1919, when
Texas revised its franchise tax after the predecessor version was held unconstitutional by the United States Supreme Court, see Looney v. Crane Co., 245 U.S. 178, 191 (1917), Texas has used a single-factor test based on sales receipts. Other states consider other factors in addition to receipts. See, e.g.,
The case law applying an origin-based approach to the taxation of services comparable to Sirius‘s aids our inquiry. In Southwestern Bell Telephone Co. v. Combs, the court of appeals focused on the location of the “network, facilities, and/or personnel” of a telephone company. 270 S.W.3d 249, 262 (Tex. App.—Amarillo 2008, pet. denied). There, the taxpayer charged consumers for access to its local telephone network in order to complete long-distance calls. Id. at 257. The Comptroller‘s rules looked to whether there was “equipment located in Texas” to determine whether the service was performed in Texas. Id. at 261. And the court held that the services were performed in Texаs because the network and facilities from which the taxpayer‘s personnel performed the service were located in Texas. Id. at 262.
Likewise, the court of appeals in Westcott Communications, Inc. v. Strayhorn, citing the “longstanding interpretation” of the Comptroller, looked to the location of Westcott‘s employees and of the facilities from which Westcott transmitted its satellite broadcasts. 104 S.W.3d at 146-47. In that case, customers contracted with Westcott to provide informational and training services that Westcott would broadcast over satellite to its customers. Id. at 144-45. The court required Westcott to be taxed based on the location of its “broadcast transmission equipment” and “production facilities.” Id. at 145. The court rеjected Westcott‘s argument that “its services were performed where its subscribers were located” or “where the customers received the service.” Id. Instead, it held for the Comptroller on the grounds that Westcott‘s service was the provision of training, which it did through personnel, facilities, and equipment located in Texas.6 Id. at 147.
In sum, precedent confirms our reading of the Tax Code: Determining the location of performance requires looking to the physical location of the taxpayer‘s personnеl or equipment that performs the service for which the customer pays. By contrast, we see no indication that the “receipt-producing, end-product act” test advanced by the Comptroller is well-established in prior case law. Oblique references to it exist. See Westcott, 104 S.W.3d at 146-47. But it has never been used to determine where a service is performed, at least not by courts. Even the administrative decision from which it derives did not apply it as the Comptroller now attempts to do. We see no reason for the “receipt-producing, end-product act” test to play any role in our decision.
C
We turn now to the nature and location of the services performed by Sirius. The court of appeals held that the act “that allowed each Sirius XM customer to receive Sirius XM programming occurred when Sirius XM decrypted the program by activating or deactivating the customer‘s chip set in their satellite-enabled radio, which Sirius XM could do remotely.” 604 S.W.3d at 133. It concluded, “This act occurred where the satellite-enabled radio was located.”8 Id. In the court of appeals’ view, “Sirius XM was not paid by its subscribers ... to broadcast or produce television or radio programming.” Id. at 134. Instead, “Sirius XM‘s programming was
Like the district court, we disagree with this understanding of the service Sirius performs. In tax cases, courts must “not disregard the economic realities underlying the transactions in issue.” Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 637 (Tex. 2013). The economic reality here is that Sirius is a radio production and broadcasting company operating dozens of satellite radio channels from locations outside Texas. Characterizing the service Sirius performs as “decryption” elevates the technicalities of the transaction over the economic reality of the servicе performed. It is of course true—in a narrow, technical sense—that a Sirius subscriber pays to have his radio set decrypt a signal. But the economic reality of Sirius‘s business is that decryption is not a service performed for the benefit of the customer at all. Sirius‘s encryption-decryption model is not for the customer‘s benefit. It is for Sirius‘s benefit. Encryption is a barrier to access imposed by Sirius—an artificial way to manufacture scarcity—in order to extract subscription payments from customers. Those customers want to listen to radio content. They do not want decryption. They would prefer to have the content without the decryption, which would make thе content free. Sirius, of course, would not make money that way.
Characterizing the service Sirius performs for Texans as “decryption of radio sets in Texas” is like saying the service performed by The Wall Street Journal Online is a “paywall-removal service,” rather than the creation and distribution of news and opinion content its subscribers want to read. But Sirius is no more in the “decryption business” than The Wall Street Journal is in the “paywall-removal business.” Both impose an artificial barrier to render more profitable what would otherwise be a freely available—and perhaps economically unviable—product. No one would pay for Sirius‘s decryption without Sirius‘s radio content. No one would need to pay for Sirius‘s radio content without decryption, but the radio content would still be a valuable service. Encryption allows Sirius to capture a share of that value, but decryption is obviously not the useful labor that Sirius performs.9
Even if “decryption” were the relevant service, Sirius still does not perform it in Texas. The record does not reflect any evidence that Sirius sends its activation signals to initiate decryption in the chip set from personnel or equipment within Texas. By all accounts, it has no personnel or equipment here, aside from a small number of terrestrial repeaters servicing a limited area. Thus, the decryption “service“—even if it mattered—is performed from outside Texas, at the “point of transmission.” Hearing No. 10,028, 1980 WL 5466, at *5.
To the extent that the Comptroller‘s argument relies on the presence of equipment in Texas—the car radios that receive signals from Sirius—it is important to note that the receipts at issue here are from
In sum, Sirius has little personnel or equipment in Texas that performs the radio production and transmission services for which its customers pay monthly subscription fees. The court of appeals’ decision apportioning to Texas all of Sirius‘s receipts from Texas subscribers must be reversed.
D
Even under our holding today, the parties would agree that some small amount of Sirius‘s services were performed in Texas. Unchallenged Comptroller regulations require that, when services are performed inside and outside of Texas, the taxpayer must apportion to Texas the “fair value of the services that are rendered in Texas.” Former 34 TEX. ADMIN. CODE § 3.591(e)(26).10 To establish the fair value of its services in Texas, Sirius submitted in the district court a study showing the cost of performing its services. The district court accepted this analysis as sufficient evidence of fair value. The court of appeals rejected it, but it did so only after agreeing with the Comptroller on the underlying question of how to apportion Sirius‘s subscription receipts. 604 S.W.3d at 135-37.
Sirius did not raise this issue in its petition for review, but the Comptroller briеfed the issue as an alternative ground for affirmance. The Comptroller contends that even if Sirius prevails on all other points, there was still legally insufficient evidence establishing the fair value of Sirius‘s services performed in Texas. The Comptroller takes issue with Sirius‘s cost-based analysis of fair value, including its treatment of its FCC license, its handling of its subsidies, its apportionment of consulting fees, and so on.
As the court of appeals recognized, any assessment of the evidence necessary to establish the fair value of services performed in Texas hinges on which services are considered “performed in this state.” The court of appeals engaged in no analysis of the appropriateness of cost-based methods as such. Instead, its conclusion that Sirius failed to present sufficient evidence of fair value flowed from its view that the district court had misidentified the relevant service performed by Sirius. Id. Because we now reverse on that predicate question, the basis for the court of appeals’ objection to Sirius‘s fair-value evidence falls away.
No court has yet considered the Comptroller‘s argument that the evidence of fair value Sirius proffered in the district court is insufficient to support the district court‘s judgment even if Sirius is right about how to apportion its services. If the Comptroller continues to take that position after today‘s decision, it may raise the issue in the court of appeals on remand.11
The judgment of the court of appeals is reversed. The case is remanded to the court of appeals for further proceedings consistent with this opinion.
James D. Blacklock
Justice
OPINION DELIVERED: March 25, 2022